Financial Decision Making

Table of Contents

Introduction

The financial scandals occurring in the late 1990s and early 2000s clearly show that the accuracy of financial statements and information of the company is an issue that cannot be overlooked. In that regard, the decision of relying on the financial information provided from within the company by their own employees or relying on an external firm to handle such task can be of vital importance, also given that the difference might imply differences in costs as well as the company’s reputation. In that regard, this paper is addressed toward providing a brief overview of the differences between the internal audit, which is handled by the same company, and the independent audit, handled by a different firm, stating that the first cannot be sufficient, even if the internal audit followed ethical guidelines. An external audit can guarantee the accuracy, and based on the examples of the financial scandals, and the Sarbanes-Oxley Act, the independence of external audit is emphasized.

Analysis

Audit’s initial purpose is separating the interests of those who are directly handling the management of the company and those who invest money in the company, i.e. owners, investors, or stakeholders. Regardless of whether the audit is internal or external, the term independent is obligatory in both types, with the difference being in that internal audit is integral to the organization, with auditors being employed by the company, while the external audit is independent of the organization, being an independent accounting firm.

Internal audit can be defined as “an independent and objective assurance activity designed to add value and improve the organization’s operations” (FHFB Office of Supervision, 2007). An internal audit provides assistance to the management of the company, while being independent of its operations, by “bringing a systemic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes by providing objective analysis and constructive recommendations” (FHFB Office of Supervision, 2007).

External auditors, on the other hand, are “independent of the organization, and provide an annual opinion on the financial statements” (IIA, 2009). External auditors’ primary concern is the internal control structure related to the financial statement of the company, its fair representation of the company’s position, and the compliance of the records with the Generally Accepted Accounting Principles (GAAP).

The main differences can be seen in the different relations to the organization, i.e. reporting to the management or the board of directors. In that regard, it can be stated that the specifics of external audit implies occasional control in specific periods, i.e. annual, quarterly, etc, while the internal audit, performed by auditors employed in the organization, maintains constant control. In that regard, the ethical conduct is a primary part of both, and as external audit might not provide a guarantee, based on the example of public accounting firms, which abrogated [the] responsibility [of proving independent audits] for consulting contracts”, their main purpose can be seen in examining the statement originally released by internal audit.

Conclusion

In that regard, it can be seen that Sarbanes-Oxley Act, released after the Enron scandal, puts an emphasis on the independence factor, indicating “whether it agrees with management’s evaluation of its internal control” (Brigham, 2009, p. 17). Thus, it can be seen that the latter implies that both should follow ethical guidelines, with greater responsibility put on internal control that should be examined and checked by an external audit.

It can be seen that having a different firm handling an audit is a greater guarantee of the independence of opinion, and confirmation of the correctness of the internal control. Both external and internal audits can be seen as mutually exclusive, specifically given the different tasks and purposes they pursue.

References

Brigham, E. F. (2009). Intermediate financial management (10th Ed. ed.). Eagan, MN: Cengage South-Western.

FHFB Office of Supervision (2007). External and Internal Audit. Federal Housing Finance Agency. Web.

IIA (2009). How do internal and external auditors differ and how should they relate? The Institute of Internal Auditors. Web.

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